The New Competitive Economy


“To hell with the terrorists: I am moving forward with plans to add a second story to my house too. I may buy a new car for my daughter who will soon be old enough to drive. I am feeling very patriotic!”

Ed Yardeni

November 2001

Readers may not remember. I barely remembered it myself. So strange and absurd was it, that it might have been dismissed as though it had never happened – like an embarrassing love affair many years ago…

Surely, it was just a silly dream…or a joke.

And yet, scarcely 18 months ago, otherwise reasonable men and women – people who could drive down the road without posing an inordinate threat to life and limb – said extraordinary things.

“I believe that there are only two kinds of humans,” wrote Ed Yardeni. There were the forward-looking ones who understood how “the digital technology revolution is transforming our economy into the New Economy.”

“And there is the other group,” observed the chief economist for Deutsche Bank, a “backward looking crowd” that “believes that the New Economy is mostly hype.”

“The first group, gets it,” he wrote. “The second doesn’t.”

It was so simple and so easy. Once you “got it,” you could get rich. But in the following 18 months, now history, those who got it, got it good and hard.

Among those who got it, Jack Benjamin Grubman is practically in a class by himself – Homo Super Digitalis. He was Salomon Smith Barney’s leading telecommunications analyst during the height of the mania. On his advice billions of dollars were invested in “competitive local exchange carriers” and other telecom sectors.

From 1997 to 2000, telecoms borrowed nearly half a trillion dollars. So far this year alone, they’ve defaulted on $21.4 billion of it. The industry’s junk bonds are quoted at pennies on the dollar. Its stocks are down 95% and more. More than half of all defaults this year have been in the telecom industry.

“Together,” writes Gretchen Morgenson of the collapse of the telecom bubble, “they represent one of the most spectacular investment debacles ever. Bigger than the South Sea bubble. Bigger than tulipmania. Bigger than the dot-bomb. The flameout of the telecommunications sector, when it is over, will wind up costing investors hundreds of billions of dollars.”

The telecom story is, by now, well known. On the advice of Jack Grubman, Salomon Smith Barney, George Gilder, Ed Yardeni and many others, an amount that could reach nearly 10% of the entire U.S. economy has been lost. The money was lost because it was so easily found. Investors rushed into telecom issues on short notice and skimpy evidence. They were prepared to believe they would get rich…simply because they “got it”; in their sleep, perhaps, they understood the unfathomable wonders of the Telecosm. Thus, did the money roll down, with barely a nudge, into the telecoms’ ratholes.

So many billions of dollars led the telecom companies to expand their businesses far beyond what the market was willing to pay for…and in directions few wanted to go. The industry simply could not produce enough profits to justify the huge capital expenses and valuations. Finally, investors awoke and marked prices to a more realistic market.

In the meantime, Salomon and Grubman had made hundreds of millions of dollars. Grubman, alone, earned an estimated $20 million in 1999. While Grubman touted the stocks, Salomon took the companies to the market, advised on mergers and acquisitions, and helped company insiders unload their shares. On one client alone, McLeodUSA, Salomon picked up almost $100 million in fees – says Gretchen Morgensen in her New York Times article – as the stock rose from $3.33 a share (adjusted for splits) to $34.83, and then fell to less than a dollar.

Here at the Daily Reckoning, dear reader, we do not begrudge a man his good fortune. We only cite the facts as a cautionary tale to investors in the current “New Competitive Economy” boom. That’s what Ed Yardeni calls the post-New Era economy in which we now travail… Yardeni says that in “the New Competitive Economy, global competition keeps a lid on inflation and forces companies to cut costs to boost productivity.” How this is different from the Old Economy we do not know. But we are sure someone will make a buck from it…though probably not investors.

Yardeni is a marvel of wrongheadedness. Only months before his discovery of Digital Man, the Y2K crisis he warned about had failed to show up. And then, only months after his spotting of the Digital Man spores, the new man was gone – along with his new era.

This wasn’t supposed to happen. One of the great myths of the New Era was that the Federal Reserve controlled the economy so expertly that recessions and bear markets were a thing of the past. And when the U.S. economy turned down, Yardeni made yet another famous remark. The slump that was not supposed to happen could be easily cured, he said. How? With rate cuts. Even if the first rate cut in January of this year failed to do the magic, Yardeni noted, “there are still 600 basis points between here and zero.”

Now that 400 of those basis points have been used, and real rates – according to Tuesday’s Cleveland Fed report – have now dropped to a negative 3%, (2% fed funds rate minus 5% CPI), we can’t help but wonder what Yardeni is saying now.

“I do believe the September 21 low was ‘the bottom’ for this cycle,” wrote Yardeni in his November, 2001 briefing. “Crises usually trigger corrective policy responses, which prove the doomsayers wrong.

“President George W. Bush urges all patriotic Americans to fight terrorism by going shopping,” he continues. “Like President Roosevelt, he believes we have nothing to fear but fear itself. I have responded by purchasing a new Dell computer fully loaded with almost every option available including Windows XP, a flat screen monitor, and a 100-gigabyte hard drive.”

Patriotism used to require self-sacrifice. What a marvelous new world! Patriotism is now as easy as spending money and buying stocks. Express your patriotism through self-indulgence…and get rich!!

Or is Yardeni wrong again?

Your editor, showing his patriotism by going out to lunch…

Bill Bonner
November 23, 2001

Today is a big shopping day. Spiders – having strung their webs in retail shops’ doorways after the Sept. 11 terrorist attacks – are nervous. So are the retailers themselves. If crowds are thin, it will be a bad sign for the Christmas season and for the U.S. economy.

As Eric reports below, investors are expecting an upsurge. The recession appears to be ending before it ever really got started. The bear market, too. And the war against…well…the Taliban. On all fronts, it is thought, the casualties from here forward will be few and the troops will be home by Christmas.

What a marvelous new world we live in! Wars can now be fought – albeit against relatively unarmed opponents – with almost no loss of life on our side. And an 18-year bull market, and the longest period of economic expansion ever, can be corrected with an 18- month downturn that most people hardly noticed until it was over.

Here at the Daily Reckoning, we’re all for it. But we can’t help but wonder if it’s really true.



Eric Fry, reporting from Manhattan:

-“7” is probably the most important number in the world. For example, it took seven days to create the world. A few eons later, Man went to work creating the Seven Wonders of the World. And of course, a best-of-seven contest determines the winner of World Series.

– But after the number seven, “10” may be the second most important number. After all, there were 10 plagues in Egypt, 10 Commandments, and the earliest – and still most reliable – computer system relies on 10 digits.

– Now, the number 10 looms large once again. The Fed has cut interest rates 10 times in a row – the most aggressive rate reduction exercise in the Fed’s 88-year history of guaranteeing prosperity for stock market investors.

– This unprecedented monetary response to our nation’s slowdown seems to be bringing a little color to the cheeks of our economy, and the financial markets are reflecting the economy’s apparent turn for the better.

– Stocks, bonds, commodities, and the dollar all tell the same story – the slowdown that has barely begun is already over. Before we even had a chance to get used to our little mini-recession…Poof!…It’s gone.

– As if on the scent of a recovery, the NASDAQ has bounced more than 30% since late September.

– Meanwhile, bond yields are soaring like never before in history. “Rosier economic news smacked the Treasury market Wednesday,” CBS Marketwatch reports, “sending the yield on a benchmark 10-year note above 5 percent at one point for the first time since mid-August.”

– Over the last three weeks, the ten-year yield has skyrocketed from 4.1% to 4.96%.

– Even the moribund commodity markets are showing signs of life. “Copper futures rose on signs of greater-than- expected demand for wire and pipe from the U.S. construction industry,” Bloomberg reports.

– The copper price has jumped more than 10% over the last two weeks. “Even with recent declines, housing starts are on pace to reach 1.6 million units this year, exceeding the 2000 level of 1.57 units.” An average single-family home contains about 400 pounds of the metal, according to the New York-based Copper Development Association. (500 lbs. including piggy banks and penny jars).

– Likewise, Moody’s industrial metals price index has gained 5.5% since the end of October. The CRB Index has firmed about 3% over the same time-frame, despite the collapsing oil price.

– Outside of the financial markets, there are a few additional signs of the recession-that-isn’t. New York’s three leading auction houses sold a total of $390.9 million worth of art during the fall season. According to Bloomberg, the fall auctions established at least 20 new record prices for various kinds of art. In particular, one very lucky connoisseur of contemporary photography was able to snag Andreas Gursky’s “Paris, Montparnasse” for a mere $600,000.

– Bill, be sure to hang onto your snapshots of Paris!

– Now that it is looking like the U.S. economy won’t fall off a cliff, holiday sales might be better than most folks had been predicting just a couple of weeks ago.

– “Holiday sales may turn out stronger than expected,” the ISI Group predicts. The research firm bases its outlook on seven helpful trends: mortgage refinancings are surging to record levels, crude oil prices have plunged more than 30 percent over the past eight weeks, the stock market has rallied about 20 percent over the past eight weeks, numerous tax breaks take effect in January, unemployment claims are dropping somewhat, many retailers are slashing prices, and we’re getting a lot of good news out of Afghanistan.

– To judge from the price action of stocks like Williams Sonoma (WSM), investors are anticipating a very Merry Christmas indeed for retailing companies. The stock has jumped 65% percent in less than two months, and now stands at 42 times earnings.

– If consumers buy Williams Sonoma products with half as much gusto as they are buying its stock, the company will enjoy a happy New Year as well. If not…


Back in Paris…

*** A DR reader writes to explain where Harry Dent went wrong and why the U.S. economy may be tracking the Japanese. (Hint – because the Japanese are older!):

“Harry Dent JR has several books in which he predicts the economy based on U.S. demographics. And, if you read “The Great Boom Ahead”, it should be clear to many people where he screwed up. He takes the U.S. birth rate curve and shifts it by 46 years to predict the future. This is a great indicator. If he stopped there, this indicator was predicting the start of the next great depression right around now, and that is exactly what is happening now.

“But, Harry screws up his indicator by tweaking too much to curve fit his indicator to the past S&P performance. This curve fitting was totally unnecessary and…if you take a good indicator and curve fit too much, you basically screw up the indicator.

“…[T]he Great Depression is here because of demographics and what happened in Japan is just another example of how demographics change the economy. I hope you all have gold and silver. Keep in mind that I’ll tell you “I told you so!” in less than 5 years.”

*** Where do you invest when the world’s #1 and #2 economies are in prolonged slumps?

*** James Passin wrote to tell me his Russian Firebird Fund portfolio is up 44% this year.

*** “We remain bullish,” he writes. “The Russian market has a p/e of 4. The “risk free” rate is 12% (in other words, the earnings yield (inverse of p/e) is 25%, double the risk free rate). Compare this to the S&P 500. The capitalization of the entire Russian market is only $50 billion.

“The economic fundamentals are excellent (under Putin, the Russian government adopted a flat tax and legalized private land ownership, among many other milestones). Corporate governance has radically improved (and is now arguably better than in the NASDAQ or NYSE) at the largest companies. Oligarchs seem to have realized that it is easier to build wealth through the capital markets than through outright looting.”

The Daily Reckoning